A Better Remedy
Lawmakers must develop a public-private partnership to address insured losses from pandemics.
- Howard Kunreuther
- June 2020
The catastrophic impacts of COVID-19 have presented challenges and opportunities for the insurance industry as to how to deal with business interruption (BI) losses by firms that did not have this coverage due to a viral exclusion clause in their policies. Lawmakers now need to play a creative role in designing new legislation for dealing with future pandemics.
With respect to the exclusion of losses due to widespread diseases such as a pandemic, seven states—Louisiana, Massachusetts, New Jersey, New York, Ohio, Pennsylvania, and South Carolina—have introduced bills requiring retroactive coverage of BI losses. The proposed Business Interruption Insurance Coverage Act of 2020, now being considered by Congress, would nullify existing exclusions in commercial insurance policies. As noted in a recent piece in the American Action Forum, if this legislation is passed it would violate the legal concept of a contract and create litigation that could take years in the courts. It would result in losses to insurers of $220 billion to $383 billion per month, 10 times the amount in claims ever handled by the industry in a year.
Rather than considering legislation that would threaten the solvency of insurance companies, Congress and state legislators should focus their attention on developing a public-private partnership to address losses from future pandemics that will be supported by the business community and the insurance industry.
Recently, there has been an active dialogue on designing such a partnership, using the Terrorism Risk Insurance Act (TRIA) as a model for a Pandemic Risk Insurance Act (PRIA). For terrorism and pandemics, their likelihood of occurrence is highly uncertain and the potential losses can be catastrophic. Thus, there is a need for public sector involvement for insurers to want to provide coverage against either of these risks.
The Wharton Risk Center has designed a framework for developing a private-public partnership for low-probability, high-consequence events that may have relevance in designing PRIA. The losses from pandemics would be covered by businesses, the insurance industry and the federal government through the following four layers:
• Layer 1 (self-insurance by commercial enterprise): A deductible on the insurance policy would incentivize businesses to develop plans for reducing losses from a future pandemic.
• Layer 2 (private insurance): The amount of coverage provided by each insurer would vary depending on their size and the diversification of their risk across businesses. Premiums charged for this coverage would depend on the insurer's ability to estimate the pandemic risk and their risk tolerance.
• Layer 3 (reinsurance and risk transfer instruments): Reinsurers need to determine how much coverage they would offer to private insurers to handle large pandemic losses and what premiums they would set for this protection. Other forms of risk transfer, such as catastrophe bonds, would complement or substitute for reinsurance.
• Layer 4 (federal government protection): Losses that exceed the ability of the private sector would be covered by the federal government either through ex ante premiums or ex post assessments (as in TRIA) to recoup their expenditures. There is a rationale for an ex post assessment because of the difficulty in estimating an ex ante premium due to the uncertainties associated with the pandemic risk.
Congress should also consider ways to develop a catastrophic insurance program that covers future BI losses from a broad set of extreme events rather than focusing on specific hazards such as terrorism and pandemics. Any program must find a way to cover small and young businesses—those most in need.
Best’s Review contributor Howard Kunreuther is the James G. Dinan Professor Emeritus of Decision Sciences and Public Policy, and co-director of the Risk Management and Decision Processes Center at the Wharton School, University of Pennsylvania. He can be reached at firstname.lastname@example.org. Support from the Alfred P. Sloan Foundation is gratefully acknowledged.